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The Beginnings of the Stock Market

May 30, 2017 / Indexes, Investing, stock market, Stocks

By Conner W. Mays

As the old saying goes “You can’t know where you’re going, until you know where you’ve been.” In that spirit, I wanted to give a brief overview of how the stock market got started and the steps along the way to get us to where we are now, and also cover some trivia questions that can help you build up broker points in the Copper Street App.

Although most people don’t realize it, investing and/or raising capital from the public has been around for over 500 years. In the early 1500s merchants and businessmen in Antwerp, Belgium began buying and selling debt from one another. Before then, if someone needed money for a business venture, their only option was a loan from a bank or some wealthy individual. Although these early pioneers of capital markets didn’t realize it, they kick started one of the most important tools in history. Capital markets allow those with excess capital to lend it to those who are in need of capital, which is arguably one of the most fundamental drivers of economic growth.

Years later, in England during the early 1600s, The East India Trading Company began selling “shares” of the profits of their overseas trips. Embarking on voyages beyond the farthest corners of the known world was a risky venture, ships could be seized by pirates, become lost and never find their way back, get caught in a storm and sink, etc… there was simply too much risk for any one company to bear. By selling off shares of the profits The East India Trading Company also offset or mitigate the risk of their ventures, much like today’s entrepreneurs. These early investors were the first participants in the stock market, although they didn’t realize it. In the early days “exchanges” were mostly coffee shops, pubs & other gathering places around England where shareholders would go to sell their stock certificates. Investors would place their bids on these certificates and the owners of their certificates would post their asks, or the price at which they were willing to sell their share of the profits represented by the stock certificates. These boards were the inspiration of the stock tapes or tickers that scroll across the bottom of the screen today on CNBC, as shown below, or other news outlets.

Once the voyages began to pay large dividends and produce capital gains for their shareholders, other investors wanted a piece of the action. The South Seas Company (SSC) was founded in 1711 and they began selling shares of the actual company as opposed to claims against the profits from specific voyages, which is what The East India Trading Company did. SSC’s model of selling shares in the company itself was the first example of a company actually selling its equity to the public and just like that the stock market, as we know it today, came into fruition. SSC enjoyed huge demand for their equity, which allowed them to charge a premium and fund more and more voyages in search of new profits. Other businessmen started to notice the benefit of not only new capital but also the risk mitigation of placing the ownership of the company in many hands vs. just their own. It didn’t take long for many other businesses to begin selling their equity via the ‘stock market’ however, the party couldn’t last forever.

The First Stock Market Bubble

The stock market was a completely new idea and as such there were no regulations, because nobody understood the risks involved with selling equity to the public. This led to the first stock boom, because anyone could issue shares without generating any real profits. SSC also continued issue shares with no real bounds on how many they could issue. The market in England was a jungle, insider trading and artificial share price inflation was the name of the game because nobody knew any different. Additionally, anyone could issues shares regardless of their ability to generate any real profits, for example one company selling shares at the time claimed it could turn sunshine directly into vegetables! In order to meet the demand for SSC’s shares, they issued more and more new shares and profits eventually became “diluted” meaning SSC couldn’t produce enough profit (earnings) per share to satisfy the investors’ appetite for dividends and capital gains. Once this began to appear permanent, investors began to sell their shares or liquidate their positions at incredible rates, the laws of supply & demand quickly set in and the first stock market “bubble” was born. The term “bubble” is derived from the idea of a bubble inflating the prices of stocks for no real reason, as more air fills the “bubble” prices climb higher until the bubble bursts and there is no real fundamental or economic value to support the prices.

Prices of all the stocks on the market began to drop due to the number of sellers vastly out numbering the number of buyers, for example, shares of SSC which were originally issued for £100 surged as far north as £1,000 by 1720 before plummeting all the way back down to £100. Many investors that purchased shares using credit and other forms of loans were forced into bankruptcy. As a result, the crown banned new issues of shares or stock certificates, which held until 1825. This act introduced a great halt in the economic activity in London and the rest of the world that participated in these early financial markets. It is worth asking the question if this event contributed to the economic pressures that led the crown to heavily tax the American Colonies. In case you have forgotten, taxation without representation in the British parliament led to the American colonies declaring their independence and the eventual domino effect of colonial revolutions that caused to the collapse of the British Empire. How are these two events linked? Remember the first companies to enter the stock market were The East India Trading Company and The South Seas Company, here it is quite easy to make the link between a country’s well-being and the health of its capital markets.

If you have any questions / comments or general topics you would like me to discuss please let me know. Shoot me an e-mail at conner.w.mays@copperst.com

Thanks for reading!

I wrote this article myself, it expresses my own personal beliefs and opinions.

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